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India Oil & Gas
Q3FY11 Preview - Mixed bag
We expect oil marketing companies to post losses in view of
the delay in the government’s subsidy payout, but expect
other companies to post up to c15% sequential growth in
earnings
We do not foresee Q3 FY11 results surprising positively in
any meaningful way as the Q3FY11 value of earnings drivers
are broadly known
We are OW on Cairn, Neutral on RIL, ONGC, OIL (V), GAIL,
IOCL and UW on HPCL & BPCL
A mixed bag for the sector. We expect Cairn, ONGC, OIL to post moderate sequential
growth while we expect GAIL and RIL to post c15% sequential growth. Oil marketing
companies or OMCs (HPCL, BPCL & IOCL) on the other hand are likely to report losses
in view of the delay in the subsidy payout from the government. Reliance Industries
should gain from higher refining and petrochemical margins but we do not expect the
market reaction to be significantly positive in view of ongoing concerns regarding the
ramp up of gas production.
Clouded outlook. We continue to believe that a structured reform of fuel pricing is
unlikely in near term due to the prevailing high inflation and impending state elections.
This would create earning uncertainty for all government owned companies. However, we
have assumed that contribution of government owned upstream companies will be limited
to 33% of total losses incurred by the oil marketing companies on sale of fuels below
market price, while the balance will be shared between the government and the OMCs.
Private sector companies such as Cairn and RIL on the other hand stand to gain from the
higher oil price and better downstream margins.
, we expect OMCs to report losses while we believe all the other
companies will report single digit to mid-teen sequential growth in earning. While Cairn should benefit
from the ramp-up of the production from its Rajasthan field, Reliance Industries should benefit from the
restoration of production from its Panna-Mukta-Tapti fields and robust refining and petrochemical
margins. We expect Reliance Industries to report a gross refining margin of cUSD9/barrel during the
quarter. We estimate that total under-recovery for the OMCs for Q3FY13 are to the tune of INR174 bn,
33% of which is to be shared by ONGC, OIL and GAIL in the ratio of 80.2%, 10.6% and 9.2%
respectively as was the case during Q2FY11.
Investment view
Company Investment view
Reliance Industries With uncertainty continuing on further ramp-up from the KG-D6 gas fields, we believe investors are unlikely
to consider RIL as a defensive stock any more and could start to view it as a proxy for refining and
petrochemical margins. Our estimate of refining margin for the balance of FY11e and for FY12e assumes regional
margins in the mid-cycle levels, while our petrochemical margins estimates are also at the mid-cycle levels. New
initiatives are not adding significant value and we expect the stock to remain range-bound.
Cairn India Our analysis shows 40% potential upside in the resource base in Rajasthan over what company management has
guided. Our analysis is based on a potential c100% upside in oil-in-place volume from an unconventional oil-bearing
source, the Barmer reservoir, overlying the main reservoir. Another reason is a set of geological features, ‘stratigraphic
traps’ that are yet to be explored. Our probability-weighted estimate of the upside is equivalent to c40% of the current
resource base. We ascribe a value for reserves upside that accounts for c16% of our target price.
ONGC We believe that ONGC’s oil and gas reserves are attractively valued; however, we also believe that the market is unlikely
to focus on that, given the policy overhang related to crude-price realisation. We believe that ONGC will continue to bear
a substantial portion of under-recovery in FY11 and FY12, as
well. We believe after gas price hike in recent past, there are very few triggers left for the stock
Oil India Limited We believe that OIL’s oil and gas reserves are attractively valued; however, we also believe that the market is unlikely to
focus on that, given the policy overhang related to crude-price realisation. However, we prefer OIL over ONGC as we
believe OIL will continue to show growth in oil production as opposed to a steady decline for ONGC
Indian Oil Corp Ltd
Bharat Petroleum
Hindustan Petroleum
All the three oil marketing companies (OMCs) are expanding refining capacity and among them have almost full market
share in India. However, in the absence of fuel price reforms, we believe earning uncertainty will remain. Additionally, we
do not expect OMCs to get full reimbursement for the under-recovery. IOCL is moderately better placed than other two
OMCs in view of its diversified business portfolio that includes recently commissioned petrochemical plant in north India.
GAIL We believe GAIL will continue to aggregate the bulk of the increasing supply and will maintain its dominant position in the
gas transmission segment in India. However, lower than anticipated domestic gas volume and continuing high price of
LNG cargo means that the transmission volume of GAIL will remain under pressure. We anticipate utilization of expanded
HVJ (Hazira-Vijaipur-Jagdishpur) network to be a poor 60% in FY12 and 70% in FY13. The higher tariff for the expanded
network on the other hand is not enough to offset the weaker volume. Better petrochemical margins and lower
percentage of share in under-recovery will keep the stock from bearish pressures as well.
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